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Public financing with financial frictions and underground economy

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  • Erosa, Andrés
  • Fuster, Luisa
  • Martinez, Tomás R.

Abstract

What are the aggregate effects of informality in a financially constrained economy? We develop and calibrate an entrepreneurship model to data on matched employer-employee from both formal and informal sectors in Brazil. The model distinguishes between informality on the business side and the hiring of informal workers by formal businesses. Policies that reduce business informality increase aggregate output by 10.8%, TFP by 6.6%, and tax revenue by 33.2%. On the contrary, output and TFP decrease when policies reduce the intensive margin of informality, underscoring that the informal economy can play a positive role in an economy with financial frictions.

Suggested Citation

  • Erosa, Andrés & Fuster, Luisa & Martinez, Tomás R., 2023. "Public financing with financial frictions and underground economy," Journal of Monetary Economics, Elsevier, vol. 135(C), pages 20-36.
    • Handle: RePEc:eee:moneco:v:135:y:2023:i:c:p:20-36
    DOI: 10.1016/j.jmoneco.2022.12.004
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    Cited by:

    1. Luiz Brotherhood & Daniel Da Mata & Nezih Guner & Philipp Kircher & Cezar Santos, 2023. "Labor Market Regulation and Informality," Working Papers wp2023_2308, CEMFI.
    2. Camila Cisneros-Acevedo & Alessandro Ruggieri, 2022. "Firms, policies, informality, and the labour market," Discussion Papers 2022-11, University of Nottingham, GEP.
    3. Luisa Fuster, 2022. "Macroeconomic and distributive effects of increasing taxes in Spain," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 13(4), pages 613-648, December.

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    More about this item

    Keywords

    Occupational choice; Informality; Financial frictions; Public finance;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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